Why & How : Raju fudged the accounts? By Dilip Maitra, DH News Service *Based on the available information and Raju's admission, in this article Dilip Maitra try to explain a possible scenario that led to such a massive fraud. * *E*ver since B Ramalinga Raju, former Chairman of Satyam Computer Services confessed in a letter that he has manipulated the accounts of the company to inflate income and profits, all the stake holders -- shareholders, employees, customers and banks — are wondering why did Raju do this? Another question that baffled people is how did he fudge the accounts to the extent of Rs 7,000 crore without being caught by the auditors and analysts?
Based on the available information and Raju's admission, in this article we will try to explain a possible scenario that led to such a massive fraud. In an article in Deccan Herald on January 9, 2008 we have explained to what extent Satyam's receivables and liabilities were fudged. It was proved beyond doubt that not only Satyam has no working capital to run the company, it has shortfall of Rs 2,131 crore *The motive* But these manipulations were only the symptoms of a much bigger malice that is hidden in Satyam's accounts. They are the results of overstating revenue and profits for several years. Why do business men fudge income and profits? Scores of private companies in our country regularly understate their income to avoid taxes. But in case of listed companies, where the company's shares are widely held, it is the opposite. Companies often overstate their revenue and profits to show higher earnings per share, to rig up share prices in the market. According to a recent study by a foreign broking house in Mumbai, nearly 20 per cent of companies in BSE 500 list have inflated revenue and profits on their books. In case of Satyam also revenue and profits figures were inflated for several years, as Raju himself has admitted. For the quarter ending September 2008, for example, the company reported a revenue of Rs 2,700 crore and an operating margin of Rs 649 crore (24 per cent of revenue). But the actual revenue was Rs 2,112 crore and actual operating profit was Rs 61 crore (3 per cent of revenues). Raju said "The gap in the balance sheet has arisen purely on account of inflated profits over several years. What started as a marginal gap between actual operating profit and the one reflected in the books of accounts continued to grow over the years. It has attained unmanageable proportions as the size of the company operations grew significantly." * It's a cakewalk* Inflating income in a company's book is not a difficult job. Manufacturing companies with an intention to show higher sales and profits, simply tell their distributors to lift its products before the year/ quarter end by placing purchase orders much more than actually needed. Normally, only a token amount is paid for the transactions as goods are sold on long credit. In case of a software exporting company like Satyam inflating sales is far easier for three reasons. Fictitious revenue for selling software solutions are originated either from group companies incorporated in foreign countries or from a friendly customer. Since software solutions are sold or supplied online, as opposed to physical movement of goods out of a factory gate after paying excise duty, there is no record keeping by any outside agency. As revenue from software exports are tax free, there is no government authority to monitor. Generating orders from a company abroad is easy as IT companies have clients all over the world — Satyam has clients in 66 countries. Said a Bangalore-based chartered accountant who worked in a large IT company a few years ago as its CFO: "Till about four to five years ago, exporting software solutions used to be the most popular method of money laundering. Send black money out of the country through the hawala route and get it back as tax free white income by 'exporting' software." * The fall out* By inflating income, companies are able to show disproportionately higher profits because the expenses for generating the revenue are generally insignificant. Since manipulated higher profits lead to higher corporate tax and dividend payout, it is damaging for a company's financial health. Since higher income leads to higher earnings per share (EPS), a company's share become more attractive and its market capitalisation (total valuation in the market) goes up. This is exactly the game Satyam was playing. The fudging of the profit and loss (P&L) account, however, does not stop there, it affects the balance sheet too. The retained profits, after paying dividend, every year get added to the 'reserves and surplus' in the balance sheet. In Satyam's case it is not yet known how much of inflated profits were added to its Rs 7,221.71 crore reserve (at the end of 31 March 2008). The figure will be substantial as Raju himself has admitted that Rs 5,040 crore worth of 'cash in the bank' actually does not exists. Another fall out of the fictitious income and reserve, is that it forces a company to show higher amount under 'sundry debtors', that is money receivables from buyers. In Satyam's case the books show Rs 2,651.36 crore under sundry debtors but Raju said the actual amount is only Rs 490 crore. The actual figure is much lower because much of the income was non-existent. * Market cap game* The obvious question now is why did Raju manipulate the books of a respected software company that ranked fourth in the industry? The short answer, of course, is the greed to amass more wealth. To do this Raju chose to play the market cap game for two reasons. Since Raju and his family held below 10 per cent of the company's equity, he was always afraid of a hostile takeover by a raider. To make a meaningful stake acquisition very expensive valuation of the company must remain high. And a manipulative promoter does this by showing ever increasing profits by cooking up figures. Higher valuation also helped Raju to borrow huge sums of money by pledging his family's stake in Satyam. Raju himself admitted that he raised Rs 1,230 crore by pledging his entire holdings. * The property priority* Raju's family comes from a landowning community and according to various news reports Raju had an ambition to become a property tycoon. As the property market started an upward journey about four years ago Raju's family bought huge tracts of land (close to 6,000 acres according news reports), mostly with borrowed money. His ambition was to develop huge townships and commercial buildings in an around Hyderabad. He also bagged several large infrastructure projects from the AP government, including the Rs 12,600 crore Hyderabad metro rail project. But his plans suffered a severe setback as property prices crashed since the beginning of 2008, thanks to the global financial crisis impacting Indian economy. As a last resort, Raju tried to merge two of his privately-owned property companies with Satyam. This would have replaced Satyam's fictitious financial assets with real assets. But institutional investors, who hold 48 per cent stake in Satyam, protested and thwarted the bid. Meanwhile, lenders and those who had partnered with Raju by investing money, pulled the plug and pressed for return of funds. His pledged shares were sold reducing his stake in Satyam nearly to zero. Finally, Raju was left with no option but to admit the fraud. * * *http://lifexperiments.blogspot.com/ േസ്നഹേത്താെട ജഗ്ഗു :) With Love JaGGu :)* --~--~---------~--~----~------------~-------~--~----~ You received this message because you are subscribed to the Google Groups "MTA0406" group. To post to this group, send email to mta0406@googlegroups.com -~----------~----~----~----~------~----~------~--~---
